A Duty Of Consistency

 

I did not expect to see the issue in an innocent spouse context.

Stacey is the ex-husband.

Stanley is the ex-wife.

In 2004 Stacey and Stanley, while married, bought property in Texas.

In 2007 Stacey filed for divorce in Florida. The court bifurcated the proceedings, granting the divorce in 2011 but reserving jurisdiction over the property settlement.

Stacey caught the attention of the IRS. In 2014 the IRS sued to reduce his 1995 to 1997 tax liabilities to judgement. The next year (2015) the IRS issued Notices of Deficiency (NODs or SNODs) to Stanley for her 2000 to 2003 years.

In 2016 Stanley requested innocent spouse relief for the 2000 to 2003 liabilities.

Not surprisingly, there is a form for innocent spouse relief, and that form includes questions about financial information.

Stanley did not include any information on line 20 about the Texas property – or any other assets either.

In 2017 the IRS granted her innocent spouse relief for most of the liabilities from 2000 to 2003.

Meanwhile, the Florida court entered final judgement, giving Stanley one-half interest in the Texas property.

COMMENT: Perhaps this is why Stanley did not include the Texas property on her 8857 filing: she did not consider it hers until a Court said that it was.

Meanwhile, her ex (Stacey) racked up IRS debt over $3.2 million.

The IRS wanted money. In 2025 the Texas property was sold for $750 grand. His half went to the IRS; her half went to escrow until a court could figure out what to do.

Stanley knew what to do: she wanted half of the proceeds. Stacey’s tax problems were his own.

The Court disagreed with her.

Why?

It had to do with her excluding the Texas property from her innocent spouse filing.

The legal concept is called “duty of consistency.” The seminal case was Herrington in 1988. The Herringtons repeatedly entered straddle transactions on the London Metal Exchange. A straddle has two sides, and theirs had an ordinary loss in the first year followed by a capital gain in the second year. The Tax Court determined that these straddles were sham transactions, nixing one of the years when the Herringtons had an ordinary loss. The Herringtons brought suit over the second year, saying that it was unfair to have them pay tax on a capital gain when the other side (the loss year) got wiped out.

The Court was not particularly sympathetic, as one would expect with a tax shelter/sham case. The Court laid out its duty of consistency doctrine:

·       Taxpayer makes an assertion or representation.

·       The government relies on it, and

·       After the statute of limitations expires, the taxpayer wants to redo or recharacterize the earlier representation in such a way to aid the taxpayer and harm the government.

·       If the doctrine applies, the government may continue to act as if the previous representation continues to be true, even if it is not.

Now Stanley was not a shelter or sham case by any stretch, but the Court did see a duty of consistency.

·       Stanley made a representation on Form 8857 by leaving the “tell us about your assets” line blank.

·       The IRS relied on the representation when it evaluated whether Stanley was likely to experience economic hardship if innocent spouse relief was not granted.

·       Stanley was now changing her representation in a way that harmed the government.

Stanley was estopped under duty of consistency. The Court ordered her half of the sales proceeds be used to pay off Stacey’s back taxes.

Our case this time was United States v Stanley, No. 25-10687, U.S. Court of Appeals, 5^th Circuit.

Partnership Audits And BBA Graffiti

 

I am reading two amicus briefs filed with the Tax Court concerning a partnership audit.

I see that the IRS wants approximately $84 million in tax and $17 million in penalties.

Let’s talk about partnership audits this time. The issue here is caused by the IRS audit process itself.

Before 1982 the IRS would audit partnerships and – if there were adjustments – would also have to audit the partners separately. While not an issue with small partnerships, it was a significant issue with larger partnerships. Take a partnership with headquarters in Atlanta, for example. The partnership audit team might come from Georgia, but the partner audits might require IRS personnel from other states.  

Enter new rules with the Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982. The partnership would designate a representative to deal with the IRS. There was one audit to bind the partnership and partners, a single judicial review of that audit and a unified limitations period for all. Just the presence of the partnership representative (tax matters partner or “TMP”) was enormous, as this required only one audit team. The IRS did not need to chase the partners for approval. The day to day was also streamlined, as the IRS did not need to notify any non-TMPs of ongoing audit activities.

But while the partnership was binding the partners, the IRS still had to coordinate the amended partner returns. As partnerships (and now LLCs) became larger and more popular, this became an increasingly formidable task.

Knowing this, what would you change to make partnership audits easier?

I would have the partnership itself pay any additional tax resulting from the audit. The partners could settle up as they wish, but the IRS would have moved on.

For the most part, that is the new system - the Bipartisan Budget Act (BBA) centralized audit regime - effective after December 31, 2017.

There are limited exceptions to the BBA regime. For example, a partnership can opt-out of BBA if it has less than 100 partners and every partner is an individual, the estate of an individual, a C or an S corporation. This seems a large exception, but is not. For example, a trust - even a grantor trust - will disallow an opt-out. A disregarded entity (almost every Schedule C is a disregarded entity these days) will also disallow an opt-out.

Fail to opt-out and you are working under BBA rules.

COMMENT: Even if you are in BBA, you can still elect to have the partners rather than the partnership pay tax on any adjustments. This is called a “push-out” election. Mind you, you are still in BBA, but you are electing to use an escape hatch.

BTW the above means that we have two audit regimes (BBA and non-BBA) functioning simultaneously out there. A partnership tax practitioner has to know and be able to work with both.

We will discuss BBA audits only from this point on.

There is an issue with the partnership paying tax on any audit adjustments.

Here is an example:

• You incorrectly reported a $2,000 asset as being placed in service by 12/31/XX.
• This resulted in an incorrect depreciation deduction of $500.
• Self-employment income was understated by $500.
• Qualified Business Income was understated by $500.
• QBI unadjusted asset basis after acquisition was overstated by $2,000.
• You inadvertently understated ending recourse liabilities by $400.

In the old days, the accounting would be straightforward. Say you had two 50:50 partners. The accountant would go back to the original tax returns, substitute the amended numbers for the original numbers and recalculate the tax. The accountant would do this for each partner, and the effect of the audit was the sum of the two changes in final tax.

Intuitive.

However, BBA does not have a tax return like the above. BBA works off the partnership return, which is an information return and does not separately calculate taxable income or arrive at a final tax.

Let’s look at our simple example. What is the change in BBA income from the above?

• $500
• $500 + $2,000
• $500 + $2,000 + $400
• $500 + $2,000 + $400 + ($500 times 20%)
• Something else?

You see the problem: the audit adjustments are divorced from a tax return. You can talk your self into knots over what to include and what to exclude.

So, the BBA created the concept of an Imputed Underpayment (IU). Think of it as a subtotal to which we will apply a tax rate.

Start by separating the adjustments into customary tax pools; income, gain, deduction, loss, and credit.

BBA adds one more pool: non-income items. This pool is the genesis of our problems.

Next separate your adjustments between positive (increase taxable income) and negative adjustments.

Positive adjustments are always included. Negative adjustments are allowed when both the positive and negative adjustments would be reported on the same line of a Schedule K-1. The effect, of course, is to leave many a negative adjustment on the table.

Let’s next look at Reg 301.6225-1(d)(2)(iii):

Got it: gobbledygook.

The hook here is that the customary tax pools (income, gain, deduction, loss, credit) can have both positive and negative sides.

The new BBA pool however – the non-income item – is always positive. The IRS arrives at this conclusion by looking at (d)(2)(ii) above. Since it does not subtract from income, the non-income item is not a negative adjustment. Since it is not negative, (d)(iii) means it must be positive.

Once we are done with positive and negatives, we crunch everything together to arrive at a sum called the Imputed Underpayment (“IU”).

We multiply the IU by the maximum tax rate to arrive at tax due from the BBA audit.

You can see the possible danger from non-income items. Land in this pool – voluntarily or involuntarily – and you can be in trouble. Items in the pool might be indirectly used in calculating tax (say QBI UBIA, for example), but not be directly involved in any tax calculation. You are still paying BBA tax on the pool, however.

Seems to me that someone who could put you in this pool potentially has the power to bankrupt you.

With the above as background, let’s briefly look at the Site Solar Fedok Fund III LLC case.

Site Solar is an Oklahoma partnership that owns, operates, and leases mobile solar generators. It reported a loss of approximately $68 million on its 2018 tax return. It also claimed energy credits on the solar equipment.

The IRS audited the 2018 tax return. It determined that approximately $80 million in depreciable assets were not actually placed in service by December 31, 2018. The IRS reduced depreciation by approximately $63 million. Since assets were not placed in service, the IRS also reduced the solar energy credit by approximately $24 million.

Stopping there and being very liberal with the numbers, we might say that a tentative IU is $104 million ($80 million plus $24 million).

The IRS calculated the IU to be $227 million.

Which translated into tax of approximately $84 million and penalties of $17 million.

How did we get from $104 million to $227 million?

Beats me.

Granted, there are rules to avoid double-counting, more specifically the “subsume rule” of Reg 301.6225-1(b)(4):

COMMENT: The subsume rule is far from perfect. Say for example that the IRS reclassifies an ordinary loss to a capital loss. The ordinary loss is a positive adjustment. The capital loss is a negative adjustment. They will not offset, as they appear on different lines of Schedule K-1. The partnership can wind up with tax due when its taxable income did not change a jot.

Treasury has explicitly stated that an IU is not intended to be the amount of tax that the partners would have owed. It instead is an entity-level calculation, disregarding whether any adjustments would have resulted in an actual tax liability to an actual partner.

Huh?

Maybe we need to regard that last point a bit more, folks. This otherwise is just scribbling numbers on a wall – BBA graffiti if you will.

I understand how this ended up in Court.

The taxpayer had no choice.

Our case this time was Site Solar Fedok Fund III, LLC v Commissioner, U.S. Tax Court Docket 19733-23.

Is A Zero-Return Partnership A Valid Tax Filing?

 

I remember when they were called Chief Counsel Advices. IRS employees – think revenue agents or officers in the field – would reach out to their employer – the IRS – for guidance on an issue.

I am looking at something called a Chief Counsel Email.

Everything changes.

It caught my eye because I was talking with a CPA last week on the very same issue.

And the IRS position is initially disturbing.

Let’s go over this.

A revenue agent (commonly called an auditor) wanted to know if an initial partnership return showing partner information but zeros for activity would constitute a valid tax return.

COMMENT: I have seen this situation many times, including last week. Someone obtains a federal EIN, putting the entity on the IRS radar. The entity then goes on to do … nothing. It never starts or starts a year or two later. Meanwhile the entity is on the IRS Christmas card list. Fail to file a return and the IRS may send a letter asking why you did not file. In response, practitioners usually file an initial return but show zeros as activity because… well because there has been no activity.

Here is the Email:

We agree with the RA’s memo that the initial return showing ownership information, but containing all 0s would most likely be considered invalid under application of the Beard test.

Not good.

To be fair, however, I do not think that it is difficult to work with this Email.

Let’s first talk about Beard.

Beard was a tax protestor.

He found himself in Tax Court over his 1981 return. He received a Form W-2, which he reported on the form 1040. He then inserted a line he described as “Non-taxable receipts” and subtracted his W-2. The result was that he owed – according to him – no taxes and was entitled to a full refund of his withholding.

The IRS wanted tax, of course, and also wanted penalties for failure to file a return. He filed something, but tampering with the forms voided the filing.

Beard responded that he obviously filed a return. The IRS was out of line saying that he had not.

The issue before the Court was: what is a tax return?

The Court presented a four-part test:

1. Does it purport to be a tax return?
2. Is it signed under penalties of perjury?
3. Does it include enough information to calculate a tax?
4. Does it represent an honest effort to satisfy the tax laws?

Beard – a protestor – missed the third test by altering the form.

Here was the Court on the fourth test:

The tampered form here is a conspicuous protest against the payment of tax, intended to deceive respondent’s return-processing personnel into refunding the withheld tax. Since such intentional tampering could go undetected in computer processing, respondent was forced to develop and institute special procedures for handling such submissions. The critical requirement that there must be an honest and reasonable attempt to satisfy the requirements of the Federal income tax law is clearly not met."

Back to our Email.

Numerous tax court decisions have found that a return (typically a 1040) containing all zeros, even if filed on an official IRS form, does not constitute a valid tax return.”

True, but …

However, these are all in the tax protestor context and other cases have held that a zero return may be valid if there is reason to believe that it is an accurate reflection of the taxpayer’s activity.”

Got it.

I will start including a schedule or attachment to the partnership tax return stating the following:

XXX Partnership/LLLC was formed on XX/XX/XX and no business operations occurred during its initial tax year ending XX/XX/20XX.”

Easy.

But it is a trap for a non-tax specialist.

This time we discussed CCA 2026030612260600 a/k/a Chief Counsel Email 202634014.